Financial advice practices are starting to look a lot more like accounting practices through acquirers’ eyes, a paper dissecting the local advice M&A market has found.
In addition to being valued at a lower multiple of recurring revenue, modern-day advice practices are finding free cash flow (FCF) generation more difficult, the paper, produced by AZ NGA CEO Paul Barrett, noted. Barrett’s insights into merger and acquisitions for practice owners follows a series of columns he wrote exclusivity on the topic for Professional Planner.
The growing similarities between financial planning and accounting is reflected in recent valuations, Barrett said.
“It wasn’t that long ago that financial planning businesses were attracting multiples of 3.2 to 3.3 times recurring revenue across the board… that has come back considerably to around 2.5 to 2.7 times,” he said.
“Accounting firms have consistently been valued at between 0.7 to 1.2 times revenue. Top firms can command up to 1.4 times,” he added.
The similarities between advice and accounting practices don’t end at valuation multiples, Barrett continued. While financial planning practices have traditionally been able to generate FCF thanks to the ongoing revenue streams they’re known for, the advice industry’s move towards more of a fee-for-service model is jeopardising its unencumbered cashflow generation.
“Compared to other sectors and professions, financial planning has traditionally been more profitable with higher levels of FCF, but the shift to fee-for-service has seen FCF gradually disappear off balance sheets,” he said.
FCF is what separates corporatised businesses from backyard operations – it is the cash left over after a company has paid its operating and capital expenditures, Barrett described.
“It is one of a company’s most important financial metrics alongside its wages bill,” he said, a branch of the topic described in one of his earlier contributions. “While FCF has been a feature of advice practices, it has never been a feature of accounting firms’ balance sheets.”
Backed by Italy’s AZIMUT Group, AZ NGA has completed 65 transactions in the past five years which collectively represent over $100 million in revenue, according to Barrett.
Buyer’s market
Based on AZ NGA’s recent transaction experiences and the growing number of practices for sale, Barrett summarised that the financial advice industry is in buyers’ market – perhaps, he said, for the first time in Australia’s short financial planning history.
In this current market, acquirers will ascribe higher value to efficiency and growth, he said.
“As a general rule, where a business has revenues of $1.5 million or less and a high EBIT margin, we tread with caution because of the small business valuation trap. In our experience, businesses of this size can’t sustain high EBIT margins once they’re absorbed into a larger firm because their overheads and costs are artificially low making them appear more profitable. In these cases we assume a more realistic EBIT margin for valuation purposes,” he described.
“At a high level, any company that can consistently grow Net Profit after Tax (NPAT) is what every investor (but not necessarily buyer) is searching for.
“Other good news for buyers is that more stock is coming on the market, as older advisers seek to retire ahead of the introduction of tougher education and training requirements,” he said.
“Even businesses that aren’t officially on the market seem more willing to engage in conversation. But succession planning isn’t always about retirement. A raft of reasons influence a business owner’s decision to sell.”
“Heightened risk” is a major risk factor which has led to people selling their business, Barrett added.
“This is evidenced by the hasty exit of the institutions from personal advice, which isn’t only because it’s increasingly difficult, if not impossible, for them to compliantly push product through aligned channels, he said. “It’s also because they are liable for the actions and advice of their authorised representatives going back decades. It’s time to draw a line in the sand.”
